DB investment guidance

Setting an investment strategy is complex, so it’s important for trustees to take the appropriate advice where necessary. To help with this, the Pensions Regulator has recently updated its guidance for trustees looking to set investment strategies for defined benefit schemes.

The guidance forms part of the Regulator’s strategy to make occupational pension schemes simpler. Made up of six parts, it provides practical examples and factors for trustees to consider when settling on an investment strategy, and is to be read alongside the Regulators’ other guidance on scheme funding and integrated risk management.

Here’s an overview of what each section will tell you:

1. Governance: This part provides advice on setting up an appropriate governance structure for a scheme’s investment. The Regulator recognises that the central purpose of trustee’s investment is to generate returns, so the guidance stresses the need for trustees to have effective governance arrangements in place and that they are documented appropriately.
2. Investing to fund defined benefits: Here the Regulator refers to guidance by the Law Commission on all of the legal obligations that trustees must adhere to when making investment decisions. It includes considerations to help trustees formulate, refine and revise their strategies, as well as balancing the risk and return in light of evolving scheme circumstances and objectives over time.
3. Matching DB assets: The guidance here reminds trustees that it’s a legal requirement for scheme assets to be properly diversified and emphasises the need for them to understand why schemes invest in matching assets, as well as the principal characteristics of the liabilities or cash flows that they’re trying to match. This includes considering the risks involved in using matching assets, such as leverage issues, collateral management when using derivatives, and concentration risks.
4. Growth assets: The fourth section details how trustees may find it helpful to consider whether the return on the growth assets are contractual (e.g. a bond investment), or non-contractual (e.g. equity investment). It also points out that using a framework that considers the underlying drivers of return can help trustees to gain knowledge of how their growth assets may perform in different economic and market environments.
5. Implementation: This part highlights why it’s important that trustees have a prioritised strategy in place to manage and mitigate operational risks. They should consider operational risks, asset transitions, the security of scheme assets, liquidity and collateral management, as well as the need for operational due diligence before appointing any third party involved in managing scheme’s assets.
6. Monitoring: Once an investment strategy is in place, its performance must be monitored. The Regulator states that trustees should be encouraged to focus on the key drivers of funding level change and investment performance, and monitor them in a timely manner in order to take appropriate action when necessary. They should consequently identify the key information that is needed to do this and ensure it is presented clearly, as well as making arrangements to monitor and review investment managers’ performance.